Seeing Past the Noise

Below is a copy of a note I recently sent to our investment management clients about the market’s recent turbulence. We thought it might be of interest to share more widely.

Seeing Past the Noise

Okay, it’s been a lousy week as markets have gyrated back and forth. It’s always hard to pinpoint the exact trigger behind a market jolt, but we all know the market was getting ahead of itself. Did we really believe we were going to be able to pocket the market’s 6% rise in January, coming after a year of +20% growth? We were bound to see a correction at some point, well here it is.

It helps to be reminded that market corrections are not unusual and for the last few decades have occurred every 18 months or so. As the chart below from today’s New York Times reminds us, they have even occurred with some regularity in the past ten years when the market has done very well overall.

S&P 500 Index Since 2008

Am I concerned? On the one hand, no. The fundamentals of the global economy are phenomenal at the moment. Every major economy is growing, corporate profits are very healthy and rising, unemployment is at a multi-decade low and consumers are happy and spending at a good clip. And very importantly, western banks and hedge funds are dramatically less leveraged than before and so the core financial system is much healthier. What’s not to like?

One thing not to like in my view is the spending bill Congress just passed early this morning and I honestly think that fears over its passage contributed to yesterday’s rout. At its core, the deal unlocks the caps imposed by the 2011 Budget Control Act enabling the military to get $320B more additional spending over the next two years (including the overseas contingency fund), domestic programs are to get $130B in new spending, and $90B has been earmarked for storm-related relief. Fully two-thirds of the total is not offset by spending reductions and so in total, the bill is expected to add $1.5 trillion to the deficit in the next 10 years. This is coming on top of the $1.5 trillion cost to the deficit of the recent tax reform bill and the $1.5 trillion infrastructure plan the government is set to announce next week!

I’m no fan of Senator Rand Paul but I appreciate him sounding the fire alarm. It is hard to believe that we are not going to see more inflation when you stimulate an economy that is already at full employment to the degree implied by the above spending. And interest rates are also bound to increase. Indeed, the NY Times is reporting today that the US Treasury is set to borrow almost $1 trillion more in this fiscal year and $1 trillion more in each of the next two years to fund the spending and the (ever-increasing) deficit.

I think the markets are telling the government that it’s potentially making a huge policy mistake. It’s too much, too fast and very ill-timed. The problem is that no one seems to be listening. But I am watching and we all should be.

What does all of this mean for portfolio strategy? Those of you who have been clients for some time will know that I do not believe it wise to sell into a storm. Such market timing rarely works. The stock market has always rewarded the patient investor, that has to be us. What this turbulence does mean is that I will be checking in with some of you in the next weeks to see whether you are comfortable with the current level of risk in your portfolio.